Investing Insights: Autos, Walmart, and Sustainability
We check in on the auto industry, share tips for fighting inflation, and offer funds for a sustainable portfolio in this week's Investing Insights podcast.
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This week on the podcast, David Whiston shares his insights on the U.S. auto industry; Christine Benz has tips for how retirees can protect themselves from inflation; John Brick thinks that lower profitability is the new normal for Walmart; and Jon Hale has four funds for building a sustainable portfolio.
David Whiston: U.S. auto sales have seen tremendous movement since 2007 with 2008 and '09 annual declines of 18% and 21% followed by seven straight years of annual increases for 2010-16 including back-to-back record years in 2015 and '16 of about 17.5 million vehicles. The winning streak ended last year with a 1.8% decline to just over 17.2 million. So now what?
We think things are still pretty good, but we are done growing for this cycle. Unemployment and consumer confidence are some of the most important macro indicators for sales that we look at on the auto team, and we don't see a reason to be concerned--yet. Through the end of last year the number of people unemployed has declined year over year every month since May 2010 except for a 0.2% rise in September 2016. Typically though, auto sales start to fall before the number of people unemployed rises, and the broader U-6 unemployment rate of 8.2% is just above where it was when it bottomed in March 2007, so things probably stay at best flat but more likely down from here; though tax cuts and Trump's infrastructure plan are wildcards to the upside.
Leasing is a big reason for this inflection in sales. Leasing has made up about 30% of new vehicle sales in recent years from a low of under 15% in 2010. Automaker captive finance arms started pulling back on leasing last year to protect themselves from residual value risk because we are now in an off-lease boom. Until recently there was a shortage of quality late-model used vehicles, but with the number of off-lease vehicles reaching 3.6 million last year, up from 1.5 million in 2012 and growing to over 4 million by 2020, used vehicle prices can only go down. They are expected to decline in the mid-single digit range again in 2018.
For this reason, we are looking for 2018 U.S. new light-vehicle sales in the range of 16.6-16.8 million, down from 17.2 million last year.
There's still many reasons to buy a new vehicle though, as the fleet is quite old at about 11.6 years, credit is good, and tech in vehicles is rich with 4G Wi-Fi, heads-up displays, lane departure warnings, automatic emergency braking, adaptive cruise, autopilot, Cadillac will have a new super cruise system in this year, and full display rearview mirrors from Gentex, a company I cover, that gives you a much wider view of what's behind you than in a conventional mirror. The average vehicle today of about a 2007 model year is primitive in tech and safety to a 2018-19 model year.
Americans also love their light truck models (pickups, SUVs, vans, crossovers). The light truck mix last year reached over 65% of new vehicle sales, up from 45% in 2009 and it was 68% in January of this year. For the industry, light truck sales last year rose 4.4% while car models fell 11.2% for a total decline of 1.8%. What's the hottest segment? Crossovers such as the Chevy Equinox and Traverse. Crossovers last year gained 270 basis points of market share to nearly 35% of new vehicle sales, while the midsize sedan segment, vehicles such as the Toyota Camry and Chevy Malibu, lost 230 basis points to 12.8%. All car segments lost share--nearly 4 percentage points in total. With cheap gas and consumers getting multiples times the storage space without giving up much in the way of fuel economy, we do not see this trend slowing down in 2018.
Which takes me to my best idea, GM, who just put out its new generation crossovers last year, excellent timing in my opinion. GM's now entering the sweet spot of its product cycle, 2015 sedans like the Malibu, 2016-17 crossovers, and now its time for new versions of its most profitable vehicles, full-size pickups, SUVs, and Cadillac. The new generation Silverado and Sierra come out late this year on an all-new architecture that GM will use for several generations in the next decade, saving billions in development and production costs in time. I like that GM is being more aggressive in going after more lucrative crew cab business, where its mix is trailing that of Ford, by offering eight models of the new truck up from five presently. Over time this should help close the several thousand dollar/unit price gap with Ford's F-150. This truck platform will then be used over the next few years to launch a new generation of full-size SUVs such as Tahoe, GMC Yukon, and the Cadillac Escalade.
Speaking of Cadillac, it finally gets more crossovers this year with the XT4 to complement the XT5, currently Cadillac's only crossover. There's a larger XT6 reportedly coming out next year, and a small crossover, XT3 in 2021, and the new Escalade in 2020.
GM is also this year completing its $6.5 billion gross cost reduction program relative to year end 2014 levels, and these cost cuts are a big reason why the company can keep earnings before autonomous vehicle investments relatively flat versus 2017, despite a declining U.S. industry and rising commodity cost pressures. We also love that management is $10.5 billion into a $14 billion share buyback program and pays a dividend that we think will not be touched in a downturn, currently yielding about 3.6%.
Jeremy Glaser: Inflation fears have taken center stage again and it could be a particularly nasty problem for retirees. I'm here with Christine Benz, she is our director of personal finance, to look at some asset classes that might help retirees hedge against that inflation a bit.
Christine, thanks for joining me.
Christine Benz: Jeremy, great to be here.
Glaser: Retirees could be particularly vulnerable to inflation as they have a lot of areas of their spending--like healthcare, property taxes, long-term care--going up faster than general prices, and also, they may have a more conservative portfolio. When you think about people in retirement, who do you think is the most vulnerable to inflation and who can sit back a little bit?
Benz: In the category of people who can sit back, you want to think about two key things. You want to think about where you are getting your in-retirement cash flows. Say, you are lucky enough to have a pension that is inflation-adjusted and is supplying most of your cash-flow needs in retirement, you are a person who has to worry less about inflation as it relates to your portfolio.
On the flip side, if you are someone who is drawing actively from your portfolio--you don't have a lot of inflation-adjusted income streams that you are bringing into retirement, and your portfolio happens to be somewhat conservative, so you have a lot of fixed-rate investments, whether bonds or cash investments--you are a person who needs to look at that portfolio and think about, what can I do with this portfolio to give it a little bit of inflation protection.
Glaser: Let's look at some of those categories, things that you could do. The first is, stocks, traditionally thought of as somewhat of an inflation hedge. Do you see that as being the case?
Benz: Definitely over long periods of time when we think about the asset class that has the best long-run shot at out-earning inflation, stocks have been it historically. They are certainly not a direct hedge against inflation on a year-by-year basis. In a year in which inflation is going up, there is no guarantee that stocks will also go up that year. But nonetheless, the fact that stocks can out-earn inflation over time, out-gain inflation is the key reason why, whenever I put together model portfolios, I typically recommend equity allocations of at least 50%, simply because retirees need that growth potential in their portfolios.
Glaser: TIPS, or Treasury Inflation-Protected Securities, inflation protections are right in there. Are they delivering on that promise?
Benz: Over time, yes. They have been a pretty good bet if you are looking for something in your portfolio that will hedge against inflation. They are the most direct hedge against inflation. I do think that they are a good addition to retiree tool kits. The key thing that retirees have to keep their eyes on--and this is something that's bubbled up very recently--is that TIPS tend to be pretty interest-rate sensitive, and that's only logical because when inflation worries are running high, that's often when we are seeing interest rates popping up. That's one reason why I tend to like the shorter-term Treasury inflation-protected bond products, because they deliver that inflation protection without a lot of interest-rate related noise.
Glaser: How about real estate?
Benz: Real estate is an interesting idea, in part because typically as inflation has been rising, we also see higher rents coming online. As a REIT owner, even an owner of residential real estate, you benefit even as you are having to pay higher prices for other things to go about your business. On the flip side though, like Treasury Inflation-Protected Securities, REITs tend to be pretty interest-rate sensitive and that's something we have seen on display very recently, too, where as higher yields have been coming online, people have been saying, well, why do I want this volatile REIT asset when I could own Treasury bonds or other bonds that are coming to market with higher yields? That's the trade-off that real estate investors face.
Glaser: What about precious metals?
Benz: Precious metals, when you look at the data--and a lot of academics have looked at this over the years--even though they have been held out as a good hedge against inflation, in general I don't think it's a great direct hedge against inflation. Another thing that you need to keep in mind is that precious metals tend to be extraordinarily volatile. They can be difficult for individual investors to own whether a precious metals fund or other precious metals investments. I typically don't recommend them as standalone holdings in retiree portfolios.
Glaser: What about other commodities though, like oil?
Benz: That's an interesting idea and certainly, there was a lot of enthusiasm for commodities as an inflation hedge a decade ago. A decade later we have seen a lot of the commodities-tracking investments, which use futures to obtain commodities exposure, really suffered due to this negative roll yield problem where you've had a disconnect between commodities prices and the returns that people investing in these products have pocketed. I don't see this category as a must-have for people who are worried about inflation.
Glaser: We went through a lot of asset classes there. If you are looking for specific fund to purchase or to invest in, what are some of your best ideas for retirees looking for inflation protection?
Benz: I like Vanguard Short-Term Inflation-Protected Securities Fund. It's a very low-cost product, very plain-vanilla. As we discussed, it removes the interest-rate sensitivity from the equation. It invests in short-term TIPS. I think that that's a decent product. Our analyst team also likes FlexShares iBoxx 3-Year Duration TIPS ETF, also pretty low cost. I think it has an 18-basis-point expense ratio, also focuses on the short-term TIPS. PIMCO also has historically done a job in the real return space. PIMCO Real Return is another product that our analyst team likes. The key thing to bear in mind there is that you want to focus on the institutional share class if you can obtain exposure to it. The other share classes are a little bit costly for my taste.
Glaser: Christine, thanks for sharing your thoughts on inflation today.
Benz: Jeremy, great to be here.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
John Brick: Walmart reported fourth-quarter earnings this morning which showed a continuation of its strong top-line growth. E-commerce sales were up 23%. U.S. same-store sales were up 2.6%, really showing the firm's ability to drive traffic.
The shares were down almost 10% in the early hours as people were diagnosing the strong competition in the space; their higher costs associated with shipping and e-commerce front; and third, the firm's investment in technology and in-store initiatives. All of this together really has dampened the firm's profitability and have constrained it longer term, and we think it's more of a new normal, a lower profitability for Walmart.
Shares are trading at about $95. We believe investors should wait for a higher margin of safety, as our fair value is $88.
Jon Hale: Sustainable investing involves the use of environmental, social, and corporate governance, or ESG, criteria to evaluate investments or to assess their societal impact. It's not hard to build a portfolio of funds around sustainable investing because the approach is used across a variety of investment categories. For investors interested in building a sustainable portfolio, our analysts have identified several funds that would make great core holdings.
Alex Bryan: Vanguard FTSE Social Index is one of the cheapest and best diversified ESG funds around. It relies primarily on negative screens to filter out stocks with businesses tied to tobacco, alcohol, gambling, nuclear power, and adult entertainment. Stocks must also have a baseline level of diversity to be included in the portfolio. As a result of these exclusions, the fund does have certain sector tilts; it tends to underweight energy and industrial stocks and overweight technology and financial services stocks, which gives it a bit of a growth tilt. It still provides a pretty well diversified portfolio covering about 70% of its selection universe. It can allow some firms with mediocre ESG characteristics into the portfolio, but still does a pretty good job of avoiding the worst ESG offenders. Its low fee and broadly diversified portfolio should continue to serve investors well.
Brian Moriarty: Investors in the market for an ESG fund should consider TIAA-CREF Social Choice Bond. This is designed to form the core of a fixed-income portfolio, but it also employs a unique impact investing strategy. Going beyond traditional ESG screens, the fund looks for bonds that finance projects with defined and measurable impacts on ESG goals. This can introduce some liquidity risk into the portfolio, because many of these deals are small. The fund offsets this by holding a sizable stake in Treasuries. Thus far, the fund has shown that ESG investors don't have to give up return potential. Over the trailing five years, the fund's 2.7% annualized return has beat more than 90% of intermediate-term bond peers. Add in low fees, and this is the fund that investors should look into.
David Kathman: Amana Growth and Amana Income are a couple of funds that have historically been aimed at Muslim investors and followed Islamic investing principles, which means they don't own alcohol, tobacco, gambling, pornography stocks, or financials stocks because of the prohibition on paying or receiving interest. They have always had a fair amount of appeal to non-Muslim investors because of their solid track records and their tendency to own nice solid blue-chip companies that don't have a lot of debt and are very profitable. In recent years, the managers have started putting more emphasis on environmental, social, and governance principles that don't specifically have to do with Islamic law or Muslim investing principles, and these funds are still pretty solid funds that have a lot to offer to a lot of different investors.
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